What Is the Best Interest Contract Exemption?

The Best Interest Contract Exemption (BICE) was a regulatory component established by the Department of Labor (DOL) in 2016. It was created to redefine the responsibilities of financial professionals providing advice on retirement accounts. The goal was to ensure that when an advisor recommended investment products that generated a commission, the advice was in the client’s best interest, addressing potential conflicts of interest.

BICE permitted financial advisors to earn compensation that would otherwise be prohibited by conflict-of-interest rules, provided they adhered to strict protective conditions. It targeted advice related to retirement assets in accounts like Individual Retirement Arrangements (IRAs) and 401(k)s. Although BICE is no longer an active regulation, its principles have influenced subsequent rules that govern the financial industry.

The Original Framework of the Best Interest Contract Exemption

The Best Interest Contract Exemption was built on a structure intended to protect retirement investors. At its core, the exemption required a written contract between the financial institution and the retirement client. This contract was a formal acknowledgment that the advisor and their firm were acting as fiduciaries, legally obligating them to prioritize the client’s financial interests and creating accountability.

A central part of the BICE framework was adherence to the “Impartial Conduct Standards.” These standards obligated advisors to provide prudent advice, receive only reasonable compensation, and ensure all statements to the client were not materially misleading.

To use the exemption, financial institutions also had to provide disclosures to their clients. These disclosures illuminated potential conflicts of interest by detailing the fees and compensation structures associated with investment recommendations. The rule applied to financial professionals, including broker-dealers and insurance agents, when giving advice on retirement plans governed by the Employee Retirement Income Security Act of 1974 (ERISA) or the Internal Revenue Code. The framework covered transactions like recommending a rollover from a 401(k) into an IRA where the advisor would then earn a fee.

The Transition to Current Regulations

The Best Interest Contract Exemption ended following a 2018 decision by the 5th U.S. Circuit Court of Appeals that vacated the entire DOL Fiduciary Rule, including BICE. The court ruled that the Department of Labor had overstepped its authority in redefining who qualifies as a fiduciary under ERISA. This decision eliminated the BICE framework and reverted the industry to previous, less stringent standards for retirement advice.

The court’s ruling created a regulatory gap, which prompted the DOL and the Securities and Exchange Commission (SEC) to develop new rules to address conflicts of interest in investment advice. In response, two regulations have emerged to shape the current landscape. The SEC introduced Regulation Best Interest (Reg BI), and the DOL implemented Prohibited Transaction Exemption 2020-02 (PTE 2020-02). These two regulations form the primary framework for “best interest” standards.

Current “Best Interest” Requirements for Investors

Today’s investor protections are primarily defined by two distinct but related regulations that build upon the concepts introduced by BICE. These rules come from the Department of Labor and the Securities and Exchange Commission.

Department of Labor’s PTE 2020-02

The Department of Labor’s Prohibited Transaction Exemption 2020-02 (PTE 2020-02) addresses conflicts of interest related to retirement advice. It allows financial professionals to receive compensation for recommendations, such as rolling over assets from a 401(k) to an IRA, if they meet several conditions designed to ensure the advice is in the client’s best interest.

Under PTE 2020-02, a financial professional must provide the client with a written acknowledgment of their fiduciary status. They must also adhere to impartial conduct standards, which mandate giving prudent advice, charging no more than reasonable compensation, and making no misleading statements. Before a rollover is executed, the advisor must provide a written document explaining the specific reasons why the rollover recommendation is in the client’s best interest. This analysis must consider factors like the alternatives to a rollover, including the costs and features of the existing 401(k) plan versus the proposed IRA.

The regulatory landscape for retirement advice remains contested. In 2024, the DOL finalized its Retirement Security Rule, which was intended to amend PTE 2020-02. However, a federal court issued a stay in mid-2024, halting the implementation of these amendments pending the outcome of legal challenges. As a result, the version of PTE 2020-02 described above remains in effect until the litigation is resolved.

SEC’s Regulation Best Interest (Reg BI)

The other major regulation is the SEC’s Regulation Best Interest (Reg BI), which applies to broker-dealers when they make a recommendation to any retail customer, not just those with retirement accounts. Reg BI elevates the standard of conduct from the previous “suitability” rule, which only required that an investment fit a client’s general profile. The regulation is built on four specific component obligations that broker-dealers must satisfy.

Reg BI’s four pillars are the Disclosure, Care, Conflict of Interest, and Compliance Obligations.

• Disclosure Obligation: Requires firms to provide full and fair disclosure of all material facts about the terms of the relationship and any conflicts of interest before or at the time of the recommendation.
• Care Obligation: Demands that the broker-dealer exercise reasonable diligence, care, and skill to understand the risks, rewards, and costs of a recommendation and have a reasonable basis to believe it is in the customer’s best interest.
• Conflict of Interest Obligation: Requires firms to establish, maintain, and enforce written policies to identify and mitigate or eliminate conflicts. For instance, it restricts sales contests and other incentives tied to the sale of specific products within a limited time.
• Compliance Obligation: Mandates that firms establish and maintain written policies and procedures reasonably designed to achieve compliance with Reg BI as a whole.

Together, these rules create a new standard where the investor’s interest must be placed ahead of the financial professional’s.